Types of Properties

RESIDENTIAL

Key Characteristics

Why Residential? Growth Profile and how it compares with other asset classes.

There is no doubt that Investors in Australia have always seen property as a safe option when investing. Even though the long term property market has performed in line with the long term share market, it is the last decade that has proved the stability of return within Property Investing. This is due to the fact that when you invest in property, you can potentially leverage your money and increase your returns. This is seen in the table below – in particular the consistent line of property growth against the volatile peaks and falls of the equities market.

As the below graph shows, over the very long term housing has performed in line with equities. Although one of the main reasons property has been such a popular choice is that it offers scale through gearing, providing for a greater volume of investment.

What drives the residential property market?

Population = New Households = Demand for new housing

The nation’s population is growing at a rapid rate. Melbourne in particular is growing faster than any other Australian capital city, taking approx. 1500 new residences each week (C.Joyce RP Data Rismark and BIS Shrapnel).

BIS Shrapnel estimate that by 2025 the number of ‘working households’ aged between 20-64 years, will increase by 1.2 million, with non-working retiree households forecasted to increase by 1.1 million.

This 2.3 million increase in the number of households needs to be accommodated. Irrespective of whether the occupants are renters or home owners, BIS Shrapnel predicts that around 3 million new homes with have to be built and added to the current dwelling stock over the next 15 years.

The driving effect on demand that population growth has, is further facilitated through the supply side not keeping up – as is shown in the graphs below.

A report released by The Australian Housing and Urban Research Institute earlier this year (2014), showed the following:

Time to Build Effects Supply Side

In 2000, the average detached house took only 4½ months to build

That rose to 8 months in 2010, according to the most recent available data

The median floor size of new homes was 138 square metres in 1990

It grew to 192 square metres in 2007. And not only are houses getting bigger, they are also getting far trickier to build

For builders this means more complex contracting arrangements. Unfortunately, more complex production systems are more prone to time-consuming errors being made, resulting in delays

"A 70 per cent reduction in availability of just one tradesperson … could extend the building time to 527 days"

National Housing Supply Council predicted the ongoing shortage in housing would reach 328,800 dwellings by 2015 and 640,200 dwellings by 2030

Property Price Growth is in Line with Purchasing Power

The below chart demonstrates that about 92% of the total increase in Australian house prices between 1985 and 2011 are correlated to household income growth.

All evidence indicates that housing prices have moved in line with purchasing power over the last 26 years.

Location, Location, Location.

Despite the common view that Australians live on large blocks in the outer lying areas of our major cities, the ‘land of sweeping plains’ is something of a myth when it comes to our location for living. As the below chart shows, Australia is the most urbanised population in the world. This means more of our population is concentrated in the major state capitals than is common elsewhere around the plant.

Where the US and China are large nations with populations ten and thirty times larger than Australia’s respectively, they are made up of many cities and towns of what is considered small (250,000) to medium (2-5m) to large (10m+) population centres. This diversity of population spread means that housing in these countries is spread across urban, suburban and rural areas and this makes for their markets to behave in a much less predictable and diverse manner than the Australian housing market does.

China interestingly has been promoted to the world as a nation undergoing enormous economic growth and renewal as a result of the urbanisation of its population- that is the rural villages and hamlets are making way for vast and expansive cities and traditional homes are being supplanted with high rise apartment living. Despite this persistent and growing trend, Australia still has a healthy lead of double the population being urbanised when compared to the Chinese. This means that if you live in Australia you have an eighty per cent chance of living in one of the urban capitals.

What this means for our housing market is simple. Our demand is stable and growing as a result of the concentration of our population. Unlike elsewhere around the world, a young person moving out of home does not mean moving to another part of the country. New households can be created within the boundaries of our major cities as they continue to grow- there is therefore less competition for demand from smaller and mid-sized cities spread geographically across the country. This means that investors can have predictability around the behaviour of rental yields and growth projections based on some confidence around population growth and urban renewal as well the known geographical parameters within which our major population centres will expand.

COMMERCIAL

Key Characteristics

Growth: Average 2-3% pa over last 40 years

Yield: Average 6 to 8% gross

Term: 3x3x3 or 5x5x5 year leases, yearly

Costs: Majority borne by tenant

Initially, when people think about investing in property, many of them immediately consider the residential options only. We like to show the benefits of both residential and commercial, as the commercial options are becoming more affordable and providing the Investor with:

Greater returns

Corporate tenants that maintain upkeep of property

Annual rent reviews and increases

Long leases with further lease options (eg. 5x5x5x5x5 year leases)

Investors of commercial property have not only purchased a bricks and mortar investment; they have acquired an income producing asset that will provide a long term secure, stable and growing return.

Yield Profile

Commercial Property as a ‘Bond’

This notion has become more popular since the upheaval that hit share markets in the wake of the Global Financial Crisis. Investors ran to the safety of government bonds seeking a place to invest that would have stability and surety of capital preservation. Some investors seeking higher returns than the falling yield paid on government bonds in Australia have also taken to investing in corporate bonds issued by our largest companies with high credit ratings. Again, this provides investors a sure income stream and relative safety of capital as opposed to the volatility of the share market dealing with global economic uncertainty and crisis.

Bond Basics – What is a Bond?

When a business uses investors to raise debt capital rather than equity (shares), the instrument commonly used is a bond. A bond is a long term debt obligation of the borrower or issuer. The bond purchaser is called the investor.

If the issuer enters liquidation, bond investors normally rank first, before share-holders but are behind secured lenders such as banks.

There are certain terms that apply to a bond the main ones include the following:

Principal: This is the amount of money the investor will receive on maturity. It is also the amount on which interest payments are calculated.

Coupon: The coupon is the regular interest that is paid to the investor by the issuer. The frequency can be annually, semiannually or quarterly. Coupons can be set at a fixed rate or floating rate (more on this later). From an issuer's perspective, coupon payments are normally deductible before tax whereas equity dividends are not.

Maturity: This is the date on which the investor will expect to receive repayment of the principal sum invested. Typically bonds have maturities of between 2 and 30 years. However there are bonds with longer maturities and some that never mature (known as irredeemable or perpetual bonds).

Investors buy bonds because they need to obtain a return on their money and their investment horizon is medium or long term. Furthermore, they consider the return they get to be attractive relative to the risk they are taking. The main risk is not receiving timely repayments of interest and principal.

How does commercial property act like a bond?

If you look at the key components of a commercial investment property, there are important parallels to be highlighted.

Coupon vs. Rent: A bond pays a regular income stream to the holder. It is usually a set rate of return or can be floating depending on the bond. A commercial property pays a set amount of rent to the owner, it is laid out in the lease and can, where provided for, rise in line with CPI (Consumer Price Index) or above in order to maintain an attractive rate of return.

Maturity vs. Ownership. When a Bond matures it can be sold back to the issuer at face value. It can also lose or gain value depending on if the coupon rate is higher or lower than the prevailing return achievable at the time of sale. The same is true for property ownership- the price of the commercial property will vary based on the rate of rental yield versus other like properties on the market at the time. A long lease will, however mean that a commercial property should not need to be sold- it can be maintained and used as in income stream producing asset for as long as the owner requires or desires.

When looking for a commercial property to take on as a ‘bond type’ yield investment, look for:

Long lease terms with long range options

Successful business as tenants

Fixed yield increases

Low carrying costs

Good Price = Lower leverage requirement

A good example: Property purchased for $350,000 with 5x5x5 lease term yield beginning at 6% with 3% fixed increase per annum.

Year 1 Rent: $21,000

Year 1 Yield: 6.00 per cent

Year 5 Rent: $24,567

Year 5 Yield: 7.02 per cent

Year 10 Rent: $28,480

Year 10 Yield: 8.14 per cent

Year 15 Rent: $33,016

Year 15 Yield: 9.43 per cent

Over the past fifteen years investors have watched their yield grow from 6% to 9.43% and have realised the income security that the property asset offers during times of turbulence across the other major asset classes.

They have a bricks and mortar real investment of true value and an income stream that is consistent and growing. Importantly, the longer the investor holds this asset the more likely the yield play will grow - the question at the end of fifteen years is – “If I sold the property now, where do I invest my money to gain a 9%+ return without taking on too much risk?”

The answer is holding the property and owning it outright will always serve an income seeking investor best.